This blog is a commentary on contemporary business, politics, economics, society, and culture, based on the values of Reason, Rational Self-Interest, and Laissez-Faire Capitalism. Its intellectual foundations are Ayn Rand's philosophy of Objectivism and the theory of the Austrian and British Classical schools of economics as expressed in the writings of Mises, Böhm-Bawerk, Menger, Ricardo, Smith, James and John Stuart Mill, Bastiat, and Hazlitt, and in my own writings.

Friday, February 21, 2014

Overthrowing Smith and Marx: Profits, Not Wages, as the Original and Primary Form of Labor Income. Reisman's Remarks at the Conferral of His Honorary Doctorate from Universidad Francisco Marroquin, July 9, 2013

Vice President Calzada
(President Calzada as of next month), Provost Castillo, Treasurer Parellada,
and friends.

I want to thank Universidad
Francisco Marroquin, in the persons of these three of its highest officials, for
the great honor just conferred on me, of an honorary doctorate in social
sciences.

Universidad Francisco
Marroquin is a rare beacon of light in a world growing intellectually dark. It
is a relatively new light, founded in 1971 by the late Manuel Ayau, the leading
advocate of liberty in Latin America and UFM’s first President. (I’m glad to
say that in 1987, my wife and I met President Ayau in San Diego, when he was a
guest lecturer at the summer conference of our organization The Jefferson
School of Philosophy, Economics, and Psychology.) Hopefully Universidad
Francisco Marroquin’s example will inspire the establishment of other
universities throughout the world that are dedicated to upholding the value of
individual freedom and capitalism.

I know that the award just
bestowed on me is all the more valuable for having previously been bestowed on
men of such caliber as Henry Hazlitt, F.A. Hayek, Leonard Read, and William H.
Hutt. All of these men, through their writings, were my teachers, most especially
Henry Hazlitt.

Now I would like to accept
this honor not just on behalf of myself but also on behalf of the two most
outstanding teachers in my life: Ludwig von Mises and Ayn Rand. Mises was the
source or inspiration for most of what I know and consider important in the
fields of economics and social philosophy. His overall, outstanding
accomplishment was to present a comprehensive, in-depth, intellectually
powerful, and uncompromising case for laissez-faire capitalism. This was
something that no one else had ever done before and which urgently needed doing—more
than anything else in the world if individual rights and the founding
principles of the United States were to be upheld. Ayn Rand greatly supplemented that knowledge, above all by
explaining, the precise nature of individual rights. I also acquired a great
deal of other knowledge from her as well, which I’ve described in my book Capitalism.

***

The first thing I want to
accomplish in the time available for me to speak, is to explain what I consider
to be one of the most important of my own original contributions to economics, namely,
my demonstration that profits are not a
deduction from wages.

The belief that profits
are a deduction from wages goes back
to Adam Smith, who is believed by many to be the leading advocate of capitalism.
In The Wealth of Nations, Smith
claims that wages are the original and primary form of income and that profits
are taken from what naturally and rightfully belongs to wage earners.

He postulates a
state of affairs that he refers to sometimes as “the early and rude state of
society” and sometimes as “the original state of things.”

In this state of
affairs he imagines that workers are producing and selling products and that
the income they receive from the sale of their products is wages. He imagines that as yet there are no businessmen or
capitalists present. Just manual workers. He assumes that because the workers
are performing labor, the income they receive must necessarily be wages. Labor
and wages in his mind are inseparable concepts. Where labor is performed, its
income must be wages, he believes.

The conditions present in his alleged “original state
of things” stand in his mind as a kind of economic Garden of Eden insofar as he
believes that the situation represents one of economic justice. It is just, he
believes, because the workers who produce the products, get to keep the full
value of the products they produce. Their wages are allegedly 100 percent of
the value of the products they produce.

But then comes the economic version of the Fall from
the Garden of Eden. Businessmen and capitalists appear on the scene. And
because they provide capital and must be remunerated for doing so, in the form
of earning profits on their capital, the workers are no longer able to keep the
full value of the products they produce. The capitalists’ profits are deducted
from what originally went completely to the workers as wages.

The Wealth of
Nations was
published in 1776. Ninety one years later, in 1867, Karl Marx’s Das Kapital was published.

Marx took over these ideas of Smith and carried them
further. He too argued that profits, along with all other income that was not
wages, constituted a deduction from wages, and that this deduction started with
the coming into being of capitalists and their capital.

Where Marx differs from Smith is that he goes further
and develops “the exploitation theory.” Smith provided merely the framework of the exploitation theory. Within
that framework, Marx propounded an elaborate analysis that attempted to show
that the nature and extent of the alleged deduction of profits from wages was
comparable to the process by which a slave owner gained from owning a slave and
that the wage earners of capitalism were in fact virtual slaves. (This is the
source of the expressions “wage slave” and “wage slavery.”)

What made the workers of capitalism slaves, according
to Marx, was the fact that, like slaves, all of their product in excess of the
portion required to keep them alive was taken by the capitalists. Indeed, the
capitalists, according to Marx, were not only willing and able to extort
profits to the extent of driving wages to the level of bare minimum subsistence
but were also motivated by the quest for profit to extend the hours of work to
the maximum humanly endurable while making working conditions brutal and
driving small children into the mines.

To this day, this is the popular assessment of the
effects of the profit motive if it is not restrained by such things as labor
unions, minimum wage and maximum hours’ laws, and child labor laws. I believe that
practically all the members of the Democratic Party and perhaps half or more of
the members of the Republican Party believe that these are the conditions that
would result in the absence of labor unions and these laws. When it comes to an
understanding of the operations of laissez-faire capitalism, that is, capitalism
free of such government interference, the great majority of people today are Marxists,
and have been since the late 19th Century.

Now it’s impossible for me to fully answer all of these
beliefs in the course of a talk as brief as this one. But I assure you that I
do fully answer them in my book Capitalism.

I will start by demolishing the framework of the
exploitation theory—the notion that originally all income is wages and that the
emergence of capitalists serves to bring into existence the phenomenon of
profit and its deduction from what allegedly was originally all wages.

All we need do to accomplish this demolition is to
realize that when a worker sells a product, such as a loaf of bread, or a pair
of shoes, he is not being paid wages.
There simply are no wages present. A wage
is money paid in exchange for the performance of labor, not for the
products of labor. Again, a wage is money
paid in exchange for the performance of labor, not for the products of
labor. In contrast, the money paid in exchange for the products of labor is a sales revenue. The workers producing
products that they sell do not earn wages. They earn sales revenues.

Thus what the workers in Smith’s original state of
things and Marx’s equivalent, which he called “simple circulation”—what these
workers receive are not wages but sales revenues.

And because there are no capitalists and thus no
spending to buy anything that would serve in the production of the goods the
workers are selling, there are no money costs
to deduct from the sales revenues these workers earn.

Let me pause here. Costs of production are always the
reflection of expenditures of money made for the purpose of bringing in sales
revenues. These expenditures are made by capitalists.
In fact, Marx and Smith agree that the essential feature of capitalistic
activity is buying for the sake of selling at a profit. Where there are no
capitalists, there is no such buying. But if there is no such buying, there can
be no money costs. At the same time, for the same reason, there are no wages
paid in production. Wages paid in production are the money that capitalists pay
to workers to produce the products that the capitalists plan to sell.

The inescapable implication of this is that in the
starting point that Smith and Marx have chosen, namely, workers producing and
selling products in the absence of capitalists, the income of these workers is profit, not wages. These workers have
sales revenues but they have no money costs of production to deduct from their
sales revenues, because no one has acted capitalistically and spent any money
to bring in those sales revenues. It follows that 100 percent of these workers’
sales revenues is profit.

It follows further that so far from being responsible
for the creation of profit and its deduction from wages, what the capitalists
are actually responsible for is the creation
of wages and costs of production, including costs of production on account
of spending for capital goods such as materials and tools, and thus for the reduction in the proportion of sales
revenue that is profit. A true statement, in direct opposition to Smith and
Marx, is that capitalists create wages
and reduce the proportion of income in
the economic system that is profit.

***

I’ve established so far that profits are an income
attributable to the performance of labor in the conditions postulated by Smith
and Marx as their starting point, indeed, the only such income in those
conditions, since there are no wages paid in production without the existence
of capitalists.

Now are profits earned by capitalists, rather than
the manual workers of Smith’s “original state of things,” are these profits also
an income attributable to the performance of labor—namely, to the labor of the capitalists, the people who earn them in
the conditions that follow “the original state of things”?

Can the profits of business Titans, ranging from John
D. Rockefeller and Henry Ford to Steve Jobs and Bill Gates be understood as
being earned on a foundation of their labor? For their manual labor may go no
further than jotting down thoughts, dictating memos to subordinates, and
reading reports.

Remarkably, a major clue to the answer is provided by
none other than Adam Smith, about 200 pages after he presented the views I’ve
criticized. Here he points out that what drives the economic system and
determines how the great bulk of its labor is used, is the various plans and
projects of the capitalists, who use their capital for the purpose of earning
profit.

I believe that all by itself
this qualifies capitalists as workers and producers. It captures the essential
element of being a producer, namely, providing guiding and directing
intelligence to the means required to achieve the goal of producing a product.

A manual worker uses his arms
to produce his product. What makes him a producer is not the fact that he uses his
arms, but that his mind directs the
use of his arms to achieve the goal of producing the product. His mind provides
guiding and directing intelligence to
his arms and to whatever tools, implements, or machines he may use in the
production of his product.

Now a capitalist supplies goals
and provides guiding and directing intelligence not merely to his own arms and
whatever tools or implements he may personally use, but to an organization of men,whose material means of production he has provided. A capitalist is a producer by means of the organization he controls and
directs. What is produced by means of it, is his product.

Of course, he does not produce
his product alone. His plans and projects may require the labor of hundreds,
thousands, even tens of thousands of other workers in order to be accomplished.
Those workers are appropriately called “the help”—in producing his products. Thus, the product of
Standard Oil is primarily the product of Rockefeller, not of the oil field and
refinery workers, who are his helpers. It is Rockefeller who assembles these
workers and provides their equipment and in determining what kind of equipment,
tells them what to produce and by what means to produce it.

I hasten to point out that the
standard of attribution I have just used, is the standard usually employed, at
least in fields outside of economic activity. Thus history books tell us that
Columbus discovered America and that Napoleon won the battle of Austerlitz.
What is the standard by which such outcomes are attributed to just one man? It
is by the standard of that one man being the party supplying the goal and the
guiding and directing intelligence at the highest level in the achievement of that
goal.

Now I also want to point out
that everything I have said is perfectly consistent with the well-known fact
that in business the amount of profit a firm earns tends to vary with the size
of its capital. Of course it does. A businessman who owns one store or one
factory will earn a certain amount of profit. If he owns ten such stores or
factories, it should not be surprising that he earns ten times the profit. His
labor is of an intellectual nature and thus can be applied the more extensively
the larger is the capital he owns. In ignorance of this fact, Adam Smith
assumed that in order for profits to be attributable to the labor of a
capitalist, they would have to be proportional to his labor, and since they
were more likely to be proportional to his capital, this precluded their being
attributable to his labor.

***

Now I think I have succeeded up
to this point both in demolishing the framework of the exploitation theory and
in demonstrating the fact that the profits of capitalists are a fully earned
income, attributable to their labor by virtue of their providing the goals of
their firms and the highest level of guiding and directing intelligence
required to achieve those goals.

I now want to demonstrate in
briefest essence how capitalism operates in diametric opposition to the claims
of the exploitation theory about wages, hours, and working conditions.

Here’s how it does so. Namely,
based on the combination of saving and investment, mainly by capitalists, and
the profit motive and competition that drives the capitalists, the output of
goods per worker under capitalism tends continually to increase.

This is the source of progressively
rising real wages. Accordingly, the average wage earner can afford to buy more
and more as time goes on.

A major advantage of being able to buy more is being in a position in which
one can afford to earn less. In the
early years of the Industrial Revolution it was necessary for many people to
work 80 hours a week to earn enough to be able to live. (Before that, many such
people didn’t live. They died of malnutrition and accompanying disease.) A
generation or two later, after the output per worker had doubled or tripled, thanks
to the capitalists, the average worker came to be in a position in which he
could afford to accept the lower earnings of a shorter work week. In fact, he
could afford to accept wages lower in greater proportion than his hours were
reduced. This made it actually profitable for employers to shorten the work
week, with or without any laws or regulations requiring it.

On the same foundation, people could afford to keep their children at home
longer. This was because the earnings of children were less and less required
for families to survive. In this way, with or without legislation, child labor
progressively disappeared.

And again, on the same foundation, workers came to be able more and more to
afford to bear the cost of improvements in working conditions of a kind that
benefitted them but did not pay for themselves through improved efficiency.
They could afford to accept lesser earnings accompanying more desirable jobs.

***

My overall conclusion is very simple. It is that contrary to Smith, Marx,
and the prevailing state of public opinion, a profound harmony of interests exists between wage earners and capitalists. Capitalists
not only earn their incomes, but in the process benefit everyone else. They pay
wages and use their wealth in the production of ever more and better products
that the wage earners can afford to buy. The more and bigger the capitalists,
the greater is the demand for labor and the larger the supply of products.
Everyone’s actual self-interest lies with the capitalists being free to earn
the profits they richly deserve and use them to accumulate as much wealth as
possible, for that wealth serves everyone who sells his labor and buys
products.

The case for capitalism is virtually unknown, however. And when it is presented,
it is viewed with great suspicion, because the influence of Marxism is so
ingrained that it is widely taken for granted that capitalism can serve the
interests of no one but a handful of capitalists, who are allegedly the
exploiters of the great mass of mankind.

Nothing will change until capitalists themselves learn to value their
achievements and recognize the actual good they accomplish for everyone. And neither
that nor anything else that is necessary will occur until universities begin to
teach the value of capitalism.

Universidad Francisco Marroquin is in the forefront of the enormous and
vital intellectual change that is needed. I’m proud to have been recognized by
it for my contributions to this cause.